New mechanism for attracting investments and avoiding future blackouts
On 4 April 2019, the Belgian Parliament approved a Bill on the capacity remuneration mechanism (‘CRM’). This system aims to ensure the security of electricity supply after Belgium’s nuclear ‘exit’ and should encourage investments in energy production facilities. It will remunerate capacity providers for making capacity available, and have a system of reliability options to avoid windfall-profits.
Will there still be enough power after the nuclear ‘exit’ to avoid blackouts at certain times? Security of electricity supply is becoming one of the biggest challenges for Belgian companies. During this winter (2018-19), security of supply was a key topic resulting in the implementation of ad hoc measures for avoiding a possible blackout. Such a blackout would mainly affect companies located in a zone that, according to the decoupling plan, will be decoupled at an early stage. As the date of the complete nuclear ‘exit’ approaches, Belgium urgently needs to take action to avoid blackouts.
Approved Bill to replace the Strategic Reserve and to attract investments
To ensure its security of supply, Belgium introduced a strategic reserve in 2014 as a backup for peaks in demand during the winter period. However, the European Commission only approved this strategic reserve for a period of 5 years, i.e. until the winter of 2021-22. Consequently, in a few years, the strategic reserve will have to be replaced by a different system. Moreover, according to an Elia (the Belgian TSO) study, the gradual phase-out of nuclear power stations between 2023 and 2025 will require at least an additional 3.6 GW of new capacity. Only a fraction of this capacity will be provided for if no additional market mechanism is activated from 2025. Thus, to avoid future blackouts, the Belgian Federal Government and Parliament believe that Belgium urgently needs a type of capacity remuneration mechanism in the short term to guarantee the balance between electricity demand and supply.
For this reason, on 4 April 2019, the Belgian Federal Parliament approved a Bill on the CRM. This approved Bill is very similar to a preliminary draft Bill agreed upon by the Belgian Council of Ministers on 11 January 2019.
The Bill opts for a system with the following characteristics:
- The total amount of capacity required is determined in advance after which a market-based process will be used to determine the price to be paid (a volume based mechanism);
- All capacity required to ensure security of supply receives remuneration, including both existing and new providers of capacity (a market-wide mechanism);
- The total amount of required capacity is set centrally, and then procured through a central bidding process in which a central purchaser procures the necessary capacity on behalf of the suppliers/consumers (a centralised mechanism);
- The selected capacity providers receive a remuneration fee for the capacity they guarantee, but have a payback obligation if the market price exceeds a predetermined strike price (mechanism of reliability options).
Such a volume-based, centralised market-wide mechanism is according to the European Commission, likely to be the most appropriate for addressing long-term concerns regarding supply security while limiting distortions of competition and trade. The use of reliability options strengthens this position as it avoids windfall-profits as shown by existing practices in Ireland and Italy.
Capacity providers are solely remunerated to make capacity available
This CRM solely remunerates capacity providers to make capacity available by paying a fee (the ‘Capacity Fee’). This Capacity Fee does not depend on whether the electricity was produced and sold, but on the participation of the capacity in the mechanism. Next to this Capacity Fee, the participating capacity providers, when the capacity is produced, still receive income from the ‘spot’ markets and the markets for ancillary services against the market price, which will remain the most important form of revenue for many capacities. To avoid windfall-profits when the market price is high (by combining a high market price with the Capacity Fee), capacity providers must reimburse the positive difference between the market reference price and a predetermined strike price for the capacity for which they are selected (‘Payback Obligation’). This Payback Obligation does not depend on whether the electricity was produced and sold, but on the participation of the capacity in the mechanism. This creates an incentive to produce when the price is high: after all, capacity providers must comply with the Payback Obligation, regardless of whether the electricity was produced and sold or not. These obligations are included in the capacity contract to be signed by the provider.
Hence, there are three different cash-flows for the participating capacity:
The level of such a ‘strike price’ must be determined in an extremely careful way. If the price is set too low, then capacity providers are not inclined to participate in the system as the reimbursement of the positive difference with the market price might be higher than the received Capacity Fee. Nor can the strike price be set too high, as this results in fewer incentives for the capacity providers to produce at times of scarcity.
Two auction rounds (T-4 and T-1) to include as many capacity providers as possible
Elia will organise two rounds of auctions to select the capacity providers. Each eligible production capacity provider located in the Belgian control area must submit a file as part of the pre-qualification procedure. Other capacity providers (such as storage, demand-side management, or foreign capacity providers) are entitled, but are not obliged, to participate.
A Royal Decree has to determine the criteria and/or modalities for eligibility for the pre-qualification procedure. These criteria and/or modalities are intended to:
- make it possible to participate in the pre-qualification procedure for capacity holders who benefit or have benefited from support measures;
- determine the minimum threshold in MW below which capacity providers cannot participate in the pre-qualification procedure;
- determine the conditions which holders of foreign direct and indirect capacity must comply with in order to participate.
Simultaneously with the submission of the pre-qualification file, a capacity holder aiming to obtain a capacity contract for a longer period than the standard period of 1 year (contracts for 3, 8 and 15 years are allowed as well) submits a detailed investment file to the Belgian energy regulator (CREG). These differentiated durations are justified by the fact that new (and to a lesser extent revised or renewed) capacities, require longer depreciation periods. From an economic point of view, it is not desirable to depreciate such investments over only one year.
Any capacity provider that is selected after the pre-qualification procedure, may, but is not obliged to, participate in the auction. A capacity provider may thus decide not to submit bids for all or part of its capacity, but must inform Elia of that in advance.
The first auction will be organised four years before the first year of supply so that providers of new capacities are able to compete effectively with other capacities (T-4). A second auction will take place one year before the supply date to refine sufficient capacity, while reserving a minimum volume for demand management (T-1).
Participants in the auction offer a determined volume of capacity in exchange for a determined level of remuneration. This remuneration should allow providers to cover their costs, taking into account their expected revenues from the ‘spot’ markets and the markets for ancillary services, so as to encourage them to enter or remain active on the Belgian market. Thus, capacity providers must organise their bids at the level of the ‘missing money’ they expect without the Capacity Fee. Even though Elia has yet to determine the modalities of the auction, there will always be a risk that the Capacity Fee is higher than the level of the ‘missing money’ of the capacity providers, according to a PWC study upon which the CRM is based.
The entire set of the CRM’s operating rules and contracts is set by Elia (and approved by the CREG) and the CREG will monitor the CRM’s proper functioning. These operating rules and contracts also establish the penalties to be paid by a capacity provider when not complying with its obligations. Additional obligations may be imposed on new capacity providers, in order to sufficiently monitor the construction of the capacity facility in the period between the conclusion of the capacity contract and the actual supply period.
Alternative procedures under exceptional circumstances
Given Belgium’s nuclear ‘exit’ by 2025 and the need for additional capacity at that time, the first auction should take place in 2021 (as the construction time of a thermal power plant is four years, being probably one of the longest throughput times of all technologies). In the event of an urgent situation in which security of supply would not be resolved by the implementation of a CRM or if the adoption of the CRM would not occur in time, then the approved Bill provides for an alternative and exceptional procedure, being the “targeted auction procedure”. This procedure, if the European Commission agrees to it, allows the Belgian King to determine the necessary parameters (including the volume to be pursued), according to the principles of the normal mechanism as much as possible. Furthermore, the approved Bill delegates the power to take every appropriate action directly or indirectly resulting in more capacity to the King, if, despite the implementation of such mechanisms, security of supply remains at risk.
In its advice on the preliminary draft bill, the Belgian Council of State raised several concerns. The most important ones are the finance mechanism, the substantial delegation of regulatory powers to Elia (a TSO which is not subject to parliamentary control), the concerns regarding state aid and the different treatment of foreign and Belgian capacities. The bill does not take into account most of the remarks of the Council of State. Some of the concerns can be addressed through future Royal Decrees but other concerns may result in legal uncertainty of the CRM.
The implementation of this CRM is a next step in the transition towards an energy sector based on an increasingly prominent role for renewable production facilities. The next essential step is to halt the uncertainty about the planned nuclear ‘exit’, as that is the main reason why additional investments are being withheld and legal certainty on that subject is vital for organising the auctions.
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